Tax cuts for low and middle-income earners and a $100 billion infrastructure splurge over 10 years are the centrepieces of the 2019-20 (FY20) federal budget.
While the budget is expected to return to surplus in the financial year starting in less the three months’ time after 11 successive years of deficit (Figure 1), a lot can happen between now and the end of FY20 - either to erode the expected wafer-thin surplus - or indeed to propel it higher, depending on the trajectory of economic growth.
Figure 1. Plots actual and prospective budgets balances between 1969-70 and 2022-23, alongside real GDP growth. When GDP growth slows, the budget balance deteriorates, albeit with a lag. Conversely, when the economy is accelerating, the budget balance usually improves. The chart is relevant because it highlights that the trajectory of economic growth could easily be a far more potent influence of whether the budget returns to surplus in FY20 than any or even all of the spending/revenue initiatives.
The budget forecasts real gross domestic product (GDP) to grow by 2¾ per cent in FY20, about the same as actual growth in FY18, but half a percentage point stronger than the official federal Treasury forecast for the current financial year.
Household consumption accounts for 55 per cent of GDP over time. The budget forecasts it to grow by 2¾ per cent in FY20, again about the same clip as FY18, but also about a half of a percentage point faster than this financial year.
Household consumption has been sluggish for a few years now in the face of anaemic wages growth, and even then, households have been running down saving to sustain growth in by far the biggest part of the economy.
The federal government cannot do much directly to trigger an acceleration in wages growth, so the budget incorporates modest tax cuts for low to middle income earners, starting as soon as when taxpayers receive their tax returns for the current financial year.
Targeting tax cuts at lower and middle-income earners, at least in the short-term, should give the budget a bigger bang for its buck than if they were aimed at higher income earners, who would likely save rather than spend a bigger proportion of the tax cut. Which should make household consumption stronger than it otherwise would be.
But whether household consumption, and indeed the economy more broadly, grows at or above Treasury’s forecast clip in part depends on whether one or more of the key external risks overhanging the national economy were to crystallise.
Apart from the possibility that the recent recovery in global equity (stock) markets gives way to another big fall, the performance of China’s economy is by far the biggest issue for Australia’s economy in FY20 and beyond.
Canberra’s coffers have been boosted by surging prices for the coal and iron ore that are Australia’s two biggest export earners. The budget wisely assumes prices for both commodities to retreat by the end of FY20. Supply constraints for iron ore from Brazil are likely to be overcome, while environmental imperatives in China itself are equally likely to trigger a slackening in growth for both the metallurgical coal used in steel-making and the steaming coal used in power generation.
And China overtook New Zealand last year as the chief source on inbound short-term visitors (including students) to Australia. A very competitive Australian dollar in recent years has been good for tourism and educators. More generally, the trajectory of the Australian dollar is a key driver of how much local currency revenue exporters derive when they sell their wares overseas.
Treasury does not make any assumptions on the Australian dollar, other than a technical one that it remains unchanged until FY21 at the level prevailing when the budget was framed - namely “around 71 US cents”.
While federal Treasury, in common with the Reserve Bank, assumes an unchanged Australian dollar in its forecasts, the federal government’s chief mineral and energy forecaster, the Department of Industry, Innovation and Science (DISS) assumes that the Australian dollar will average 74 US cents in FY20, then 75 cents in both FY21 and FY22, then 78 cents in FY23 - the last year of Treasury’s forward estimate horizon (Figure 2).
Figure 2. Plots the Australian dollar’s actual value for the US dollar on financial year average basis from 1969-70, the DISS assumptions between FY19 and FY24. It also plots Treasury’s technical assumption of an unchanged exchange rate to FY23. If the currency averages at or below the DISS assumptions, Australia’s exporters will have enjoyed more than eight years of a very competitive and stable currency compared to when it was above parity with the US dollar all through 2011 and 2012.
A trajectory of the Australian dollar closer to the DISS assumptions rather than Treasury’s technical assumption would not necessarily of its own right be enough to derail the return to budget surplus. But it would make it more difficult to achieve. Moreover, apart from external factors, including China, the outlook for household consumption is also in part contingent on how much further house prices in Sydney, Melbourne and Perth fall in coming months. If house and other dwelling prices do not find a floor soon, existing owners will be less inclined to spend on discretionary household goods and services - although prospective home buyers will find it easier to break into the market for the great Australian dream.
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